Friday, May 21, 2010

The FinReg bill is good news for the many who have argued that the financial sector is bloated, absorbing too high a share of the nation's profits, attracting a disproportionate share of talent and wielding dangerous influence over public policy. The Wall Street Journal's Randall Smith:

The Senate version of financial regulation hits Wall Street harder than expected, with some analysts estimating it could cut the profits of major financial institutions by roughly 20%...

Goldman analysts recently tried to quantify the impact of the changes likeliest to survive, including already adopted caps on fees for checking accounts and credit cards, as well as restrictions in the Senate bill on proprietary trading with the banks' own money and the House curbs on derivatives. Those elements alone could shave 17% off bank earnings, Goldman said. Less-likely changes could boost the hit to 23%.

Glenn Schorr, an analyst at UBS AG who follows financial stocks, said Wall Street could recoup some of the lost profit through higher volumes or by keeping pay below historical levels. A derivatives-trading spinoff could free up capital for redeployment elsewhere.

The degree to which the legislation curbs current banking practices has stimulated a kind of wonder, even in that most trenchant of regulatory Cassandras, Simon Johnson.

Johnson, convinced from the beginning that the Obama team was hostage to regulatory capture, asserts that it was not Obama or his core financial team that drove the toughest reforms, but a cadre of centrist senators, along with Commodity Futures Trading Commission head Gary Gensler (derivatives), Paul Volcker (proprietary trading ban), Mary Schapiro (suit against Goldman) and Elizabeth Warren (strong consumer protection agency). Johnson claims that Obama is not a "centrist" but in effect strongly conservative when it comes to preserving the megabanks' size and core prerogatives -- inclined to preserve "the devil we know."

Johnson's charge at this point reminds me a bit of the Monty Python "what have the Romans ever done for us" routine (nothing, except reduce crime, build roads, open schools, etc. etc.). The White House strongly supported Warren's consumer protection concept; it backed Gensler on derivatives; and Volcker won Obama's ear. Johnson admits as much:

On consumer protection, Elizabeth Warren paved the way, and the administration — to its credit — largely followed her lead. On derivatives, Gensler has brought us to a better — though far from ideal — set of rules. On compliance, Schapiro is picking the SEC up off the floor.

The White House supports Warren consistently, has been brought around to Gensler’s approach and hopefully will stick by Schapiro.

He concludes nevertheless:

But the biggest banks have simply proved too powerful to overcome without sustained and intense counterlobbying by the White House.

As a result, the financial system could well remain largely as it was before September 2008. Perhaps the megabanks will be slightly constrained in their activities; most likely not — at least for Goldman, JPMorgan Chase and Morgan Stanley.

Prepare now for new extremes.

Johnson, then, is still proclaiming regulatory capture -- even as he, too, betrays some level of amazement at strength of measures that did get through. The piece is a bit of a bait-and-switch: Obama's not responsible for the strength of the reforms -- and anyway, the reforms aren't very strong.

Indeed, the largest banks have not been broken up. The amendment that would have limited their size as a percentage of GDP failed. The Volcker rule -- whichi survived only in weak form in the Senate bill -- is but a sliver of Glass-Steagall.

But the consumer protection agency should forestall the kind of absurd mortgage lending that triggered the crisis. Derivatives trading will be cleared and regulated. The Federal government has the authority and means to liquidate large failed banks. Proprietary trading curbs of some kind will probably become law. (And the Kanjorski Amendment, which empowers regulators to break up large institutions that they deem to pose a risk to the financial system, is in the House bill -- does it have a chance to survive House-Senate negotiations? Kanjorski is promising to fight for it.)

In the world as we know it, that's strong reform. And like the HCR bill, it's only the foundation for a new architecture. How it's implemented and how it evolves through further legislation will determine how successful it is.